Mortgage discount points: when buying down the rate pays off

What a point is

The CFPB defines one point as 1 percent of the loan amount. On a $100,000 loan that is $1,000. Points can be fractions, such as 0.5 or 1.375 points. They are paid at closing as part of your closing costs.

Points should buy a lower rate than the same lender would give you with zero points on the same kind of loan. More points should buy a lower rate again. The CFPB notes that by law, points listed on the Loan Estimate and Closing Disclosure must be connected to a discounted rate. How much each point lowers the rate depends on the lender, the kind of loan and market conditions. Sometimes one point buys a large reduction, and sometimes only a small one.

Some lenders use the word points for any fee calculated as a percentage of the loan, even if it does not lower the rate. Ask directly what each charge buys.

Where to find them

Points appear on page 2 of the Loan Estimate in section A, origination charges, as a percentage and a dollar amount. Lender credits appear in section J as a negative number. The rate is on page 1. When you compare two offers, check all three places.

The break-even month

To decide whether points pay off, divide what they cost by what they save each month. The result is the number of months before the savings repay the upfront cost. After that, you come out ahead every month you keep the loan.

This simple break-even ignores two things. The $3,000 could have stayed in savings and earned interest, and points can have tax effects. Both push the real break-even later. They do not change the basic logic.

When points make sense, and when they do not

Points can make sense when you are confident you will keep the loan well past the break-even, and when you have cash left over for reserves after closing.

Points rarely make sense when you may move within a few years, when rates might fall enough to make refinancing attractive, or when the cash would leave you with thin savings.

The CFPB's advice is practical: if you do not know how long you will keep the loan, you might not want to pay points or take credits. Ask the loan officer to show both options and to calculate total costs over the shortest, longest and most likely time you expect to keep the loan.

Lender credits, the other direction

Lender credits work like points in reverse. You accept a higher rate and the lender gives you money toward closing costs. That can help when cash is tight. The same break-even logic applies backwards: credits save cash now and cost more each month, so they suit buyers who expect to move or refinance sooner.

Comparing offers fairly

Points make rate comparisons tricky. One lender's 6.5 percent with one point is not better than another's 6.625 percent with no points unless the numbers say so. Get quotes on the same day for the same loan, line up section A and the rate, and run the calculator for each. The APR on page 3 helps too, but it assumes you keep the loan for the full term.

The bottom line

A point is 1 percent of the loan and should buy a lower rate. Divide its cost by the monthly saving to find the break-even month, then be honest about how long you will keep the loan.